Question $1(20$ marks$)$

Your company is evaluating a switch from a cash only policy to a net $30$ policy. The price per unit is $$100,$ and the variable cost per unit is $$50.$ The company currently sells $1,000$ units per month. Under the proposed policy, the company expects to sell $1,200$ units per month at the price per unit $$105.$ The probability of default is $10\%$ and the required monthly return is $1\mathrm{.}2\%.$

Assume sales and costs occur at the beginning of the month.

a$)$ Should the company offer credit terms of net $30$ to a one$-$time customer? Explain $($Support your result with calculations$)(6$ marks$)$

b$)$ What is the maximum acceptable default probability in part $($a$)?(4$ marks$)$

c$)$ The cash flow pattern in the firm is approximated by the Baumol $($BAT$)$ model. Now, the firm has $$6,000,000$ holdings in cash and zero marketable securities$.$ Over next year, the total amount of new cash needed for transaction purpose is expected to be $$4,000,000.$ The firm has to pay transaction cost $$500$ each time when it buys or sells securities$.$ The annual interest rate on money market securities is $5\%.$

i$.$ What is the target cash balance? $(3$ marks$)$

ii$.$ How much of the current cash holding should be used to increase the firm's holdings of marketable securities$?(3$ marks$)$

iii. After the investment of excess cash at part $($ii$),$ how many times will marketable securities be sold to replenish cash during the next $12$ months? $(4$ marks$)$

Question $3(20$ marks$)$

Assume that there are assets $-$ stock A and T$-$bill $($risk$-$free asset$)$ along with the market. The T$-$ bill's return rate is $5\%.$ Market portfolio has an expected return of $8\%$ and standard deviation of $0\mathrm{.}08.$ Price of stock A is $$10$ now. During next period, rate of return of the stock A will be $50\%$ if the economy expands, $20\%$ if the economy is normal and $-20\%$ if the economy falls in the recession. The probabilities that the economy is expanding, being normal or in a recession are $0\mathrm{.}3,0\mathrm{.}6$ and $0\mathrm{.}1$ respectively. The variance of the stock A$\text{'}$s return is $0\mathrm{.}0453.$ Correlation between return of Stock A and the market is $0\mathrm{.}5.$ The stock A pays no dividends.

a$)$ What is the expected return rate of stock A $?$

b$)$ What is the standard deviation of stock A$\text{'}$s return? $(5$ marks$)$

c$)$ What is the beta of stock A$?$

d$)$ What are the weights of stock A and T$-$bill if you want to construct a portfolio with beta equals $1?(3$ marks$)$

e$)$ Based on the result in part $($d$),$ what is the expected return of this portfolio? $(2$ marks$)$

Question $4(20$ marks$)$

The firm has issued $2000$ preferred stocks which pay a stated annual dividend of $$6$ per share. The preferred stocks are currently selling for $$120.$ Additionally, the firm has $1000$ corporate bonds and the bond is selling for $$1,050$ along with a yield to maturity of $6\%.$ Also, the firm has $4000$ outstanding shares of common stock selling for $$50$ per share. The common stocks have a beta of $1\mathrm{.}5.$ The market risk premium is $5\%$ and risk$-$free rate is $2\%.$ The firm is subject to corporate tax rate $25$ percent.

The firm is considering to launch a new project that is as risky as the overall firm. The project needs to make an initial investment of $$500,000.$ The project will save the firm $$200,000$ per year in pretax operating costs over the $3-$year life of the project. It will also need to make an initial investment of $$50,000$ in working capital which will be recovered at the end of the project. The project will be depreciated based on the three year MACRS class $,$ and $17\%$ respectively for years $1-4)$ and will be scrapped for $$85,000$ at the end of its useful life.

a$)$ What are the weights of each capital component in the firm's capital structure? $(6$ marks$)$

b$)$ What is the cost of each capital component in the firm's capital structure? $(6$ marks$)$

c$)$ What is the overall cost of capital to the firm? $(2$ marks$)$

d$)$ Should the firm accept the project based on the NPV analysis? $(6$ marks$)$Question $2(20$ marks$)$

The firm is trying to choose between the following two mutually exclusive projects. Assume the

discount rate is $10$ percent. $(20$ marks$)$

a$)$ Based on the IRR, which project should be accepted?

b$)$ What is main problem with IRR in the case?

c$)$ Based on the NPV$,$ which project should be accepted?

d$)$ Finally, which project should be chosen? Explain

$(5$ marks$)$

$(5$ marks$)$

$(5$ marks$)$

$(5$ marks$)$